Libor banks' interest rate fall signals end of credit crunch

The rate at which big banks borrow money from each other in the money markets slumped to an all time low today, providing the latest evidence that financial markets are returning to pre-credit crunch conditions.

Market experts say the fall in the so-called London interbank offered rate (Libor) is taking place amid mounting expectations that the Bank of England is planning to penalise banks for holding huge reserves at Threadneedle Street.

But they concede that there is little evidence that the lower market rates for bank lending are feeding through to lower rates for mortgages and other loans for consumers.

The market analyses the difference between Libor and the Bank of England base rate to gauge the level of nervousness in the City. The benchmark rate analysed – the three month sterling Libor rate – stood at 0.75% last night – compared with the historically low base rate of 0.5%.

John Ewan, director at the British Bankers Association, said: "This margin would have been fairly typical of the period between 2001 and early 2007. We've seen over the last two or three months that Libor has come in a little bit every day".

While the City believes that the base rate is expected to remain at historically low levels for some time, which could explain the steady fall in Libor, some analysts point to actions by banks to prepare for a policy change by the Bank of England.

At last week's quarterly inflation report, Bank of England governor Mervyn King said he was considering whether to introduce a new policy that might allow money to flow around the system more easily and for banks to boost lending to small businesses and households. The idea is to cut the rate banks receive for holding reserves at the Bank of England which would encourage them to withdraw their cash and put money into the markets.

Michael Saunders, economist at Citi, argued this might be a reason why Libor is falling. "You can take it as a sign that the financial system is returning to normal. There could also be a sense that the market is anticipating a policy change from the Bank of England on the fact that it could be going to be pay a lower rate on deposits," said Saunders.

Nick Parsons, head of markets strategy Europe at National Australia Bank, has supported the idea of a lower rate for deposits at the Bank of England by the commercial banks. "A less generous rate on banks' reserve assets held at the central bank might be one administratively simple method of trying to break out of the current liquidity trap," Parsons said.

Data from the British Bankers Association which compiles the Libor level shows that not all banks were able to borrow at the 0.75% level. Lloyds Banking Group and Royal Bank of Scotland, in which the taxpayer has stakes, were borrowing at 0.82% and 0.8% respectively, while Barclays was paying 0.81%. The lowest rate was reported by Deutsche Bank at 0.6% and HSBC was borrowing below Libor at 0.7%.